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Competing in Markets with Digital Convergence

Ravi Mantena and Arun Sundararajan

Last revised: January 2005

Abstract:   This paper studies competition in the presence of digital convergence, a phenomenon that has been observed in a variety of information technology industries: handheld computing, telecommunications, consumer electronics, networking, residential broadband and broadcast video, among others. Digital convergence increases the value and flexibility of products and services, but also increases the substitutability of products that were previously in distinct industries, therefore presenting a critical trade-off for managers making technological and platform scope choices. We analyze this trade-off between product value and product substitutability by developing a new model of competition in converging industries that generalizes popular models of imperfect competition, admitting endogenous product scope choices, variable substitutability across products and industry boundaries, and purchases of multiple technology products by individual consumers.

We establish four different kinds of equilibria, which characterize distinct stages of digital convergence. Our results show that early stages of convergence feature increasing prices and profitability, which eventually fall if the extent of convergence progresses beyond a critical point. However, if firms can bilaterally and strategically control the degree of convergence in their industries, their equilibrium strategies can sustain higher prices and profits even when industry boundaries blur. We also describe examples of equilibria in which consumers may buy multiple general-purpose products, using each for a specialized subset of their needs, and discuss how this may lead to cyclical demand trends between specialized and general-purpose digital products. The effect of technological changes that alter the fixed costs of expanding product scope, the variable costs of production, and the breadth of customer requirements are analyzed. Managerial guidelines based on each of our results are presented.

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